Seafood chain Red Lobster’s master lease agreements are reportedly hindering the company’s ability to manage its restaurant footprint by closing underperforming locations. As Debtwire reported, some of Red Lobster’s leases are governed by master lease agreements (which place multiple properties under a single lease) that were signed over a decade ago. A master lease arrangement, in theory, restricts the ability of lessees, such as Red Lobster, to separately treat individual leases governed by the agreement without the consent of lessors. As Debtwire reported, Red Lobster has been working with real estate advisor Keen Summit Capital Partners to, among other things, optimize its lease portfolio.

In light of Red Lobster’s Chapter 11 filing in 2024, through which it shed over 100 locations, the Debtwire legal analyst team explains how master leases are treated in Chapter 11 cases. While there are no reports that Red Lobster is contemplating a second Chapter 11 filing, its rights in a bankruptcy case would inform its lease negotiations with lessors going forward.

As further discussed below, master lease agreements are creatures of state law and their terms are, subject to limited exceptions, binding in Chapter 11. If individual leases subject to a master lease agreement cannot be broken apart under state law, then they should not be severable in bankruptcy. That said, contracts are often subject to disputed interpretations and, as we discuss below, bankruptcy courts consider various lease provisions when these disputes arise. Given the uncertainty surrounding these disputes, property owners that are parties to Red Lobster’s master lease agreements may wish to avoid risks of an adverse ruling in any potential Chapter 11 case down the road.

The road to severability is paved with clear intentions

Section 365 of the US Bankruptcy Code authorizes a debtor to assume or reject its leases in a Chapter 11 case, but the Bankruptcy Code generally does not enlarge contractual rights (with the exception of capping certain lease rejection damage claims and rendering certain anti-assignment provisions unenforceable).[1] More specifically, the Code only authorizes a debtor to assume or reject an entire lease. It does not authorize the rejection of onerous terms and assumption of those that a debtor deems favorable.

This principle applies to master leases. However, the analysis takes on complexities when a debtor requests to assume or reject some – but not all – leases governed by a master lease agreement. Disputes have arisen in numerous cases when a debtor has tried to break up leases governed by a master lease agreement by assuming some leases and rejecting others in Chapter 11. Under a true master lease scenario, a debtor must either assume all leases governed by the master lease or reject all such leases. However, like many other things in Chapter 11, the situation is not always a black and white. As the US Bankruptcy Court for the District of Delaware explained, “[t]he fact that there is one document reflecting the parties’ agreements does not mean that it is one contract. The ‘all or nothing’ requirement of assumption or rejection under section 365 does not mean . . . that every document denominated a ‘contract’ or a ‘lease’ must be treated as a single, indivisible whole. . . If a single contract contains separate, severable agreements, however, the debtor may reject one agreement and not another.”[2] One thing however remains certain; the determination of whether a master lease is an indivisible agreement – or several agreements in one – turns on state law. While state law varies and it is unclear which state law governs Red Lobster’s master leases, severability of master leases typically turns on the intent of the parties, which in turn is discerned by a review of the lease terms. If the terms of the lease are ambiguous, courts can consider additional evidence (e.g., the parties’ conduct) to ascertain the parties’ intentions.

Two Chapter 11 cases are particularly instructive. In the Chapter 11 case of steak buffet restaurant chain Buffets Holdings, the debtor sought permission to assume certain leases governed by a master lease and reject others. The landlord objected, arguing that the master lease constituted a single agreement that must either be assumed or rejected in its entirety. In considering the dispute, the US Bankruptcy Court for the District of Delaware explained that “[e]ven if the parties entered a multi-part contract, that contract cannot be severed after the fact if the parties entered it as a single whole, so that there would have been no bargain whatever, if any promise or set of promises were struck out.”[3]

The bankruptcy court concluded that the master lease agreement constituted a single agreement, and therefore the leases could not be individually assumed or rejected. In reaching this conclusion, the court looked to various provisions of the master lease agreement to determine whether the parties intended it to constitute a single agreement. For example, the court found that the fact that the master lease could, in certain circumstances, be severed by its terms did not mean that the parties intended it to constitute separate agreements for all purposes. In fact, the court found that it demonstrated the opposite – i.e., that the parties intended each master lease to be an integrated agreement except for under certain specifically identified circumstances.

Other factors supporting the court’s conclusion were that (i) the obligation to pay rent was joint and several, (ii) each tenant was liable for the entire rent, (iii) all rent remained due even if the debtors were unable to use one or more of the properties, (iv) at the expiration of the leases by their terms, the master leases could only be extended if all the ground leases were extended, (v) on default of one of the individual leases, the landlord had the right to declare the entire master lease in default or to treat only the individual lease in default, and (vi) individual leases incorporated into each master lease were economically interdependent. Because of these provisions, the bankruptcy court found that allowing the debtors to reject one of the leases without continuing to pay the total rent would destroy the essence of the landlord’s bargain.

A bankruptcy court reached the opposite conclusion in the Chapter 11 case of Cafeteria Operators. In that case, the debtors were parties to a master sublease agreement that covered several restaurant facilities. They moved to reject the agreement with respect to some, but not all, of those facilities. The lessors objected, but the US Bankruptcy Court for the Northern District of Texas ruled that the master sublease agreement was divisible under Michigan law and, thus, did not have to be rejected in its entirety.[4] 

In so ruling, the court found that the master sublease agreement evidenced the parties’ intention that the individual premises leased could be operated separately and independently of each other and severed from the master sublease agreement.[5] Supporting its finding, the court noted that (i) consideration under the master sublease agreement was apportioned among the 43 individual premises, (ii) the primary term of the master lease was different for individual groups of properties, and (iii) the debtors were required, pursuant to the terms of the agreement, to surrender the premises once the term of each individual property’s sublease was completed, even though the master sublease agreement remained in force with respect to other properties. The court further found that the agreement’s integration clause, coupled with the provisions allowing the landlord to terminate, re-enter and repossess or relet some, but not necessarily all, of the properties further evidenced the parties’ intent that the master sublease agreement was divisible.

Breaking up is (sometimes) hard to do

The two cases discussed above show that although master lease agreements will be construed under state law, there likely will be room for dispute over whether an agreement’s terms evidence an intent by the parties that the agreement is severable, or indivisible. Regardless of the applicable state law, the risk remains that different courts can construe a set of lease terms in various – and contrasting – ways, and the outcome will not always be certain. Arguably, this may present a riskier prospect for a lessor, who would have concerns regarding the possibility of creating negative precedent for future transactions. On the other hand, the ability to reject unfavorable leases could improve any sale prospects that Red Lobster may wish to pursue down the road. Although, as Debtwire reported, a Red Lobster spokesperson stated that the company is not engaged in any process to sell, the company would be more valuable to prospective purchasers without the burden of a lease package that requires payment of rent for underperforming locations.

To be clear, we have not reviewed the terms of any of Red Lobster’s master lease agreements. However, the fact that the terms could be subject to a contractual-based dispute in a Chapter 11 case raises the possibility that a bankruptcy court could construe the agreements’ provisions as evidencing an intent by the parties that the leases could be broken up. This would allow Red Lobster to assume some leases governed by a master lease agreement, while rejecting others. Depending on the terms of Red Lobster’s master lease agreements, the parties may, or may not, want to take on that fight in court.

Related Links (Access required):

Plan Profile
Case Profile
Debtwire Restructuring Database: Red Lobster Seafood Company

Prior to joining Debtwire, Sara was a law clerk to two judges in the United States Bankruptcy Court, S.D.N.Y. and practiced in the Financial Restructuring Group at Clifford Chance, where she represented financial institutions (as secured and unsecured creditors, defendants in adversary proceedings, and participants in DIP financings) in high-profile restructurings. She also represented foreign representatives in Chapter 15 cross-border cases.

This report should not be relied upon to make investment decisions. Furthermore, this report is not intended and should not be construed as legal advice. ION Analytics does not provide any legal advice, and clients should consult with their own legal counsel for matters requiring legal advice. All information is sourced from either the public domain, ION Analytics data or intelligence, and ION Analytics cannot and does not verify or guarantee the adequacy, accuracy or completeness of any source document. No representation is made that it is current, complete or accurate. The information herein is not intended to be used as a basis for investing and does not constitute an offer to buy or sell any securities or investment strategy. The information herein is for informational purposes only and ION Analytics accepts no liability whatsoever for any direct or consequential loss arising from any use of the information contained herein.

———-

[1] An additional exception, for example, is that section 365(f)(1) of the Bankruptcy Code states that provisions restricting a debtor’s right to assume and assign a lease (i.e., anti-assignment provisions) are generally unenforceable.

[2] In re Buffets Hldgs, 387 B.R. 115, 120 (Bankr. D. Del. 2008). (internal citations and quotations omitted)

[3] Id.

[4] See In re California Operators, 299 B.R. 384 (Bankr. N.D. Tex. 2003).

[5] See id. at 390.

Photo: Red Lobster